Lines of credit are a valuable tool for small businesses that want easy access to a renewable source of working capital. Credit lines can support a business through periods of low revenue and help cover emergency expenses. Similar in some ways to a business credit card, lines of credit allow access to a predetermined amount of cash. In many cases, a business line of credit is better than other options, because funds can be applied without restriction to any legitimate business expense, including payroll.
Unlike with term loans, the business can take out as much or as little of that cash as they want at a time, then come back for more as needed. Payments back to the account free up credit to be borrowed again. As long as the borrower stays on top of their payments, the account can remain open. If there’s no balance on the account, the lender typically doesn’t charge interest.
If a business line of credit sounds good to you, your next question might be, “How do I get one?” As with most loans, there are certain criteria you and your business must meet in order to qualify. These vary by lender and lenders are free to set the terms and conditions for their products. However, there is some consistency across the market due to standard lending practices. This article will cover what you need to get started. Your broker can guide you further when it comes to applying for a particular line of credit.
Personal credit will almost certainly come into play when you’re seeking a line of credit for your business, even if the business has an established credit score. That’s because it indicates several things to your lender, including how well you manage debt and your ability to pay off the loan if your business can’t.
While not every lender has the same minimum score to qualify, you stand a better chance of being approved and having access to more borrowing power the higher your score is. In general, you should strive for a FICO score of 680 or higher. You can get your score for free from one of the three main credit bureaus: Equifax, TransUnion, and Experian. Some creditors offer access to your credit report as part of their service packages.
It’s a good idea to check your score before you apply, not just because the lender’s going to. Most personal credit checks trigger what’s called a “hard inquiry” to your credit. Too many of these in a short period can negatively impact your score. Being aware of your credit report can also alert you to any misinformation that needs to be cleared up before applying for a line of credit.
Most business owners prefer to separate their personal finances from their business finances. That’s because it can protect against liability. Without this division, you’re personally responsible for the debts the business incurs. If your business doesn’t yet have established credit, the lender will use your personal credit score.
Just as with personal scores, not every lender requires the same level of business credit. It’s a good idea to check your business credit before you apply as well. Business scores can range from 0 to 100, with 100 being the highest possible score. If your score is 75 or higher, you should be in good shape to get a line of credit. You can get your score from Dun & Bradstreet, Equifax, or Experian for a fee.
There are numerous facts and figures regarding your business that lenders look at beyond your credit score. Any lender will want to do their due diligence to make sure their loan will be repaid. Your time in business, how much debt your business owes, and how much money it makes annually will all help determine your loan. Most lenders want to see two years of financials before you can qualify.
One measure of your business debt is your DSCR or Debt-Service Coverage Ratio. This is your business’s net operating income divided by its current debt obligations. A good ratio for most industries is 1.25. Another is your debt-to-equity ratio, which is the total liabilities your business has divided by its total shareholders’ equity. The qualifying annual revenue for most lines of credit is between $50K-$100K, which you’ll need to provide bank statements to prove.
The industry you’re in also matters. That’s because some industries, like restaurants, retail stores, and passenger transportation are seen as riskier than others. If your business is new, but you’ve operated another business in the same industry before, you can use that information to help you qualify. Most lenders go by your NAICS code, which stands for the North American Industry Classification System. This was formerly the SIC but was changed in 1997.
As a brief recap, here are the minimums you should be prepared to meet to qualify for a line of credit. If you’re not quite there yet, don’t lose hope! You can still find a lender! Talk with your broker to point you in the right direction.
● FICO score: 680+
● Business credit score: 75+
● DSCR: 1.25
● Annual Revenue: $50K+
● Years in Business: 2+
What if I Don’t Meet the Minimums?
If you’re looking at the figures above thinking you don’t stand a chance of qualifying for a line of credit, don’t panic. As mentioned, some lenders have different requirements and will accept a lower credit score. You can also secure a line of credit with collateral. This asset-based form of credit increases your chances of approval and gives you a higher credit limit on the line. If you own a startup and can’t demonstrate two years or more of financials, there are other ways your business can access working capital. Consider these alternatives:
Factoring is another revolving credit option that you can tap into if you have accounts receivable assets. You can sell those assets to a factoring company that will buy them for a percentage of their value. They then collect when your customer pays their invoice, purchase order, or contract. After extracting their fee, the factor sends the remaining money to you. Factoring gives you access to immediate cash without adding debt to your balance sheet.
Asset-Based Term Loans
Asset-based loans use a business’s assets as collateral. Factoring and secured lines of credit are two examples, but there are other options available. Most lenders prefer liquid collateral over physical assets, but will often accept the asset being purchased as well. For example, if you wanted to flip a property, you could secure a term loan to buy real estate, using that property as collateral. This also works for equipment, securities, and inventory, giving you ways to keep cash moving by leveraging your assets.
To recap, lines of credit are financial accounts that businesses can tap into as-needed to boost their cash flow. To qualify for one, you must meet minimum credit, DSCR, and time in business requirements. Secured lines of credit, which use assets as collateral, are easier to qualify for and may offer a higher credit limit. If you don’t meet the minimums set by the lender, there are multiple alternatives to help you access the cash you need.
The best tool in your financial arsenal is your business loan broker. It’s their job to know the ins and outs of the lines of credit available from various lenders to help you decide which is the right one for your business. When a line of credit isn’t the optimum choice, your broker will be ready with alternatives and can help you qualify. If you use a mechanic for your car and a contractor for home repairs, it doesn’t make sense to trust your wallet with anyone else.